Header Right

How to Choose the Right 529 Plan

May 5, 2017

529 plans are one of the most popular ways to save for college, and for good reason. They offer tax-free growth and tax-free withdrawals for higher education expenses, making them essentially the Roth IRA of college savings.

The problem is that there are a LOT of 529 plans to choose from. Almost every state offers at least one 529 plan, and many offer multiple, and each one comes with a different set of fees, investment options, and features.

So, how can you choose the right 529 plan for your specific needs? Here are three big factors to consider.

1. State Income Tax Deduction

529 plan contributions are not deductible for federal income tax purposes, but some states offer a state income tax deduction IF you contribute to your home state’s plan. A small number of states – like Arizona, Kansas, and Pennsylvania – allow you to deduct your contributions no matter which 529 plan you use.

If your state offers an income tax deduction, that might be enough to make it worth using your state’s plan. For example, a 5% income tax deduction on $5,000 worth of annual contributions over a period of 10 years would save you $2,500.

Let’s say that you contribute $5,000 per year and earn a 5% annual return over a 10 year period. By investing in mutual funds that charge you 0.10% per year instead of 1% per year, you would end up with an extra $3,232 in your 529 account.

Avoiding fees is always a good idea, and the website savingforcollege.com has a great 529 fee study that can help you compare plans. And depending on the other specific features you’re looking for, certain plans may end up being more attractive than others.

Making a Decision

If you’re eligible for a state income tax deduction and your home state’s plan offers low-cost index funds, then your decision is pretty easy. You can choose your home state’s plan.

If you’re not eligible for a state income tax deduction, you can simply look for any 529 plan that offers low-cost index funds and any other features that are important to you.

If you are eligible for a state income tax deduction BUT your home state’s plan only offers high-cost investments, you’ll have to evaluate whether you’re better off taking the deduction or finding better investment options elsewhere.